Investment Strategy
Can Emerging Markets survive Trade War II?
What we think
Following a strong start to the year, the outlook for emerging markets may become more volatile. This trade war will differ for EM compared to Trade War 1.0. While the previous trade conflict led to supply chain redirection that benefited several EMs, this time could be different as tariffs are expected to be applied more broadly. Additionally, China’s growing dominance in export market share is causing tension not only with the U.S. but also with many emerging markets. Emerging markets are generally driven by a combination of three factors: global trade, commodity prices, and the U.S. dollar. While these factors have been favorable recently, the tide may soon turn.
Investment implications
Although emerging markets have rallied as the dollar weakened and commodity prices rose, they remain heavily dependent on exports. With trade tensions escalating, the outlook is becoming cloudier, and investors will need to be more selective. India has experienced a sell-off, making valuations more attractive, and its small trade share of GDP keeps it relatively insulated. Tariffs, global trade, and their impact on the dollar will be the key factors overall. If the dollar continues to weaken and the tariff impact on overall trade is subdued, EMs can move higher; however, in a strong dollar environment amid a stalled global trading environment, EMs will undoubtedly feel the pressure.
Emerging Markets Amid Trade Tensions
Emerging markets (EM) have had a surprisingly strong start to the year, outperforming the U.S. in Q1 for the first time since 2018. Typically, EMs require a weak dollar, robust global trade, and a strong commodities environment to outperform. While the year began with all three conditions, the introduction of U.S. tariffs has created an uncertain trade outlook, potentially reversing these trends.
Trade is a crucial factor. During the first trade war, a prevailing investment narrative suggested that other EMs could benefit from U.S.-China trade tensions by attracting increased foreign direct investments and manufacturing as alternatives to China, which faced trade uncertainty.
However, this time is different as tariffs are being applied more broadly. Additionally, these economies now face the secondary shock of an influx of cheap Chinese imports, as China exports excess capacity amid subdued domestic demand and elevated trade tensions with the U.S. and other developed markets. This phenomenon is already negatively impacting local EM manufacturing and employment. As the Trump administration targets not just China but almost every trading partner with trade imbalances—whether due to trade deficits or tariff rate differentials—many EM economies could end up in the crosshairs. With both the direct impact of U.S. tariffs and the indirect impact of a slowing China and weaker global trade, EM economies may face tougher challenges ahead.
Did EM Actually Benefit from the First Trade War?
At a headline level, the narrative played out when comparing the evolution of the U.S. trade relationship with China and other EMs—particularly manufacturing powers like Vietnam and Mexico. The U.S. share of imports from China fell steadily from 2017 onwards, while the share from other EMs grew by almost the same magnitude.
TRADE WITH CHINA REPLACED WITH OTHER COUNTRIES
Change in share of U.S. goods imports, 2017-22, percentage points
Sources: UN Comtrade; FRB Staff Calculations, Data as of July 1, 2022.
Moreover, Foreign Direct Investment (FDI) into key EMs has steadily increased since the last trade war (albeit with some pandemic disruptions). By relocating manufacturing to regions not impacted by tariffs, producers can avoid duties and continue selling to the U.S. market. A large part of this FDI came from China (including Hong Kong), though other developed economies (the U.S., Europe, and Japan) have continued to lead in this regard.
FDI INTO KEY EMERGING MARKETS (VIETNAM AND INDONESIA) HAS STEADILY INCREASED
Total inbound FDI, quarterly, US$ millions
Sources: National sources, Haver Analytics. Data as of December 2024.
FDI HAS SHIFTED FROM CHINA TO ASEAN COUNTRIES IN RECENT YEARS
FDI flows to China and ASEAN, US$ millions
Sources: ASEAN Secretariat, World Bank, Haver Analytics. Data as of 2023.
However, if most manufacturing economies are targeted by U.S. tariffs in this trade war, there will likely be increased uncertainty over the viability of manufacturing relocation practices. Additionally, headline numbers alone may not tell the whole story. A large part of the trade shift can be attributed to transshipments—where Chinese inputs or intermediate goods make their way to these economies (with varying degrees of value-added work) before eventually ending up in the U.S.
AS THE U.S. IS DERISKING FROM CHINA, U.S. SUPPLIERS ARE RELYING MORE ON CHINESE IMPORTS
%
Sources: U.S. Census Bureau and UN Comtrade; FRB Staff Calculations. Data as of July 1, 2022.
For example, while China’s share of U.S. Information and Communication Technology (ICT) imports has fallen, with ASEAN taking up the slack, China’s value-add in ASEAN’s exports has risen. This potentially signals that these products are simply finding their way from China to the U.S. via Southeast Asian manufacturing economies.
CHINA’S SHARE OF U.S. ICT IMPORTS HAVE FALLEN IN FAVOR OF ASEAN
% of U.S. ICT imports
Source: Census Bureau, J.P. Morgan Investment Bank. Data as of December 2024.
CHINA’S VALUE ADD IN ASEAN EXPORTS HAVE GROWN
China value-add as % of ASEAN’s gross exports
Source: OECD TiVA, Haver Analytics. Data as of 2020.
Another example is Mexico, which is about to surpass China as the main exporter of tech products to the United States. However, the tech industry in Mexico differs from other manufacturing industries in a key way: the domestic value-added is low. Compared to the average 40% value-added in manufacturing exporting industries integrated into global supply chains—such as in the computer and electronics industries, which account for the bulk of Mexico's tech products to the U.S.—the domestic value-added is only around 20%.
MEXICO’S DOMESTIC VALUE-ADD IS LOW COMPARED TO THE AVERAGE VALUE-ADDED IN MANUFACTURING EXPORTING INDUSTRIES
Mexico: domestic value-added in household appliances as a % of electronic exports
Source: Haver Analytics. Data as of December 2024.
In this regard, the U.S. has not fully achieved its goal of decoupling from China, especially in sensitive and strategic sectors. These cases of low local value-add (and high China-produced content) will likely come under further scrutiny by the U.S. as it seeks to reshape the global trade landscape and close trade loopholes exploited in the last trade war.
Moreover, it is difficult to ascertain the ‘true’ economic impact of increased Chinese investments in EM economies beyond headline FDI numbers. If these manufacturers are simply sourcing a vast majority of their inputs from China (for construction, labor, capital goods, intermediate components, etc.), then the benefits to the local economy may be limited to land sales and the provision of utilities. Anecdotally, that appears to be the case, but empirically measuring the actual economic impact of these investments is challenging.
MANY GREENFIELD INVESTMENT PROJECTS ANNOUNCED BY CHINESE COMPANIES IN ASEAN WERE IN MANUFACTURING
ASEAN: Announced Chinese greenfield investment, by industry, 2020-2023, US$ millions
Source: ASEAN Investment Report 2024, UNCTAD, fdi Markets. Data as of 2023.
In addition, the Chinese influx goes beyond just FDI and transshipments—EMs are also increasingly being flooded by Chinese imports meant for domestic consumption, with potentially negative implications for the local economy.
The “China Shock” Goes Global
We have written extensively about how the U.S. has undergone significant economic shifts in terms of deindustrialization, weak manufacturing wage growth, and imbalances between capital and labor—and how some of these factors underpin the trade policies the Trump administration is currently pursuing. An interesting phenomenon today is how a similar shock could be playing out across EMs, largely attributed to China.
China’s exports started being targeted with tariffs by the U.S. in the first Trump administration (which the Biden administration maintained and, in some cases, expanded). Some manufacturers shifted production to other markets to circumvent those duties while also seeking alternative markets to sell to. A clear trend is that other EMs are taking up the slack from the U.S., as several large countries are now receiving an increasingly larger share of China’s exports.
CHINA IS INCREASINGLY DEPENDENT ON EMERGING MARKETS
Share of China’s total exports, %
Source: Bloomberg Finance L.P., IMF, national government reports. Data as of 2024.
TRUMP’S TARIFFS HAVE REROUTED CHINA’S EXPORTS
Value of China’s exports to emerging markets, US$ billions
Source: Bloomberg Finance L.P., IMF. Data as of 2023.
Notably, EM reliance on Chinese imports has grown consistently across the board, contrasting with major developed markets such as the U.S. and Japan. This points towards both trade redirection and increasing consumption of finished Chinese-made products.
CHINA DRIVES BOOST IN IMPORTS ACROSS EMERGING MARKETS
Change in each country’s share of global imports, 2017-23, percentage points
Source: UN Comtrade, Bloomberg Economics. Data as of 2023. Note: Vietnam imports are estimated for 2023 based on 2022 values
Additionally, amid a real estate collapse and inconsistent consumption, China relied on manufacturing investments and exports as a key growth driver. As a result, China’s trade surplus hit an all-time high of nearly USD 1T in 2024. This is evidenced by China’s unbalanced growth drivers—in the last two quarters, exports have made up nearly 50% of GDP growth.
CHINA IS MORE VULNERABLE TO TRADE FRICTIONS THAN IN THE PAST AS EXPORTS MAKE UP A LARGER SHARE OF GROWTH
Share of GDP growth, %
Source: China National Bureau of Statistics, Haver Analytics. Data as of 4Q 2024.
This is creating a new shock for EMs. First, EM imports from China have surged, not just in intermediate goods, which make up more advanced products, but increasingly in final goods, which displace local industry and jobs. Meanwhile, EM exports to China have dropped, contributing to growing trade deficits. Secondly, China’s excess capacity is resulting in a surge of global exports, displacing other EM products in third markets.
So, what are some of the goods being imported from China? They range broadly from higher-end products such as electric vehicles and other appliances to lower-end clothing and textiles. While importing high-quality high-end products at competitive prices is arguably positive for consumers, a flood of lower-end imports can overwhelm local producers and lead to job losses.
Already, some economies are implementing measures to curb the impact. Mexico has raised tariffs on textile and apparel imports from China to 35%, and Thailand and Malaysia have levied a 7% and 10% value-added tax on cheap imported goods to mitigate Chinese e-commerce imports. However, these economies are treading a fine line between the U.S. and China, and it is challenging to balance their extensive trade relationships with both. On one side, the U.S. is trying to strategically reshape global trade, while on the other, China is trying to boost manufacturing and exports and find alternative markets for their products. Even Russia, which has become enormously reliant on trade with China, put restrictions on Chinese car imports due to an unsustainable inflow of cheap imports. China’s auto exports have been nothing short of historic—rising to become the largest exporter and manufacturer in the world in just five years.
CHINA HAS BECOME A DOMINANT EXPORTER OF AUTOMOBILES
Auto exports by country, million units, 4-quarter moving total
Source: National sources, Haver Analytics. Data as of September 2024.
Can EM Survive the Incoming Trade War?
The fundamental nature of this trade war is different from the first, as the scope is global rather than bilateral between the U.S. and China. As such, other EMs could be hurt by 1) the direct impact of reciprocal tariffs; 2) the indirect impact of a weaker global trade environment; and 3) a flood of Chinese imports.
To gauge the first-order impact of higher U.S. tariffs, we can consider the degree to which EMs rely on the U.S. as a destination for exports. In this regard, Vietnam, Mexico, Thailand, South Korea, and Taiwan stand out. These economies also happen to have some of the larger trade surpluses and tariff rate differentials versus the U.S., which could come under heavy scrutiny by the administration.
MANY PARTS OF ASIA HAVE A LARGE EXPOSURE TO CHINA DEMAND, BUT NOT THE U.S.
Exports consumed in U.S./China as percent of GDP
Source: OECD, Haver Analytics. Data as of December 2020.
Additionally, the prospect of a weaker global trade environment doesn’t bode well for EM equity earnings. EM corporate earnings tend to follow the global trading cycle significantly. This holds true across both trade-dependent economies, such as South Korea and Thailand, as well as relatively insular markets like Brazil and India, which tend to have fairly low trade-to-GDP ratios. The reason is that most EMs have fairly shallow domestic markets, and the trends of domestic demand and domestic policy tend not to experience large cyclical swings. Therefore, some of the largest cyclical components and biggest sources of profits are often from selling goods overseas.
ASIAN EQUITY EARNINGS AND PERFORMANCE ARE DEPENDENT ON EXPORTS
Source: Bloomberg Finance L.P., Haver Analytics. Data as of February 2025
Investment Implications
Emerging Markets tend to exhibit a very strong correlation to three things—trade, commodities, and the dollar. When trade and commodity prices are strong and the dollar is weak, EMs outperform. Investors often question why this correlation exists, highlighting that EM economies are less commodity-intensive or trade-dependent than they once were, but nonetheless, this relationship holds. We note that during the Covid period, EM slightly underperformed despite the strong trade and commodity backdrop, likely because the asset class was overwhelmed by a strong dollar and persistent flows into U.S. assets.
EM EQUITIES TEND TO OUTPERFORM DURING PERIODS OF STRONG TRADE
Source: MSCI, International Monetary Fund, Haver Analytics. Data as of February 2025.
EM EQUITIES TEND TO EXHIBIT A STRONG CORRELATION TO COMMODITIES
Index level, 2005=100
Source: Bloomberg Finance L.P., MSCI, Haver Analytics. Data as of February 2025.
While today’s weaker USD and lower U.S. yields are usually regarded as a positive for EM broadly, the uncertain trade environment leads us to be more cautious and selective in this space. Furthermore, a large part of the EM outperformance this year has been led by China, and that particular rally was led by a handful of AI and tech-related names, which we don’t see as reflecting a fundamental change in the growth outlook or the global trade and economic environment. Our preferred equity markets globally are still the developed ones of the U.S. and Japan. If the dollar remains in a bear market and tariffs turn out to be less punitive than expected, the EM rally can continue. However, if tariffs are applied broadly, investors will likely have to be selective to find opportunities.
One key EM that could be less impacted by the external environment and more driven by constructive domestic factors is India, where we see a bottoming of economic momentum in sight. This could, in turn, lead to a recovery in the equity market, which has sold off significantly since late last year. We continue to see India as a long-term structural position in an equity portfolio. For long-term equity investors, it is important to consider the factors that drive EM long-term performance: economic structure, the role of private enterprise, earnings per share growth, and the role of exports.
KEY RISKS
All market and economic data as of March 28, 2025 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.
For illustrative purposes only. Estimates, forecasts and comparisons are as of the dates stated in the material.
Indices are not investment products and may not be considered for investment.
Past performance is not a guarantee of future results. It is not possible to invest directly in an index.
Investing in alternative assets involves higher risks than traditional investments and is suitable only for sophisticated investors. Alternative investments involve greater risks than traditional investments and should not be deemed a complete investment program. They are generally not tax efficient and an investor should consult with his/her tax advisor prior to investing. Alternative investments have higher fees than traditional investments and they may also be highly leveraged and engage in speculative investment techniques, which can magnify the potential for investment loss or gain. The value of the investment may fall as well as rise and investors may get back less than they invested.
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RISK CONSIDERATIONS
- Past performance is not indicative of future results. You may not invest directly in an index.
- The prices and rates of return are indicative as they may vary over time based on market conditions.
- Additional risk considerations exist for all strategies.
- The information provided herein is not intended as a recommendation of or an offer or solicitation to purchase or sell any investment product or service.
- Opinions expressed herein may differ from the opinions expressed by other areas of J.P. Morgan. This material should not be regarded as investment research or a J.P. Morgan investment research report.
- Emerging markets carry higher risks for investors who should therefore ensure that, before investing, they understand the risks involved and are satisfied that such investment is suitable. Investors must understand that transactions involving emerging markets currencies bear substantial risks of loss.
- Investments in emerging markets may not be suitable for all investors. Emerging markets involve a greater degree of risk and increased volatility. Changes in currency exchange rates and differences in accounting and taxation policies outside the U.S. can raise or lower returns. Some overseas markets may not be as politically and economically stable as the United States and other nations. Investments in emerging markets can be more volatile.
- International investments may not be suitable for all investors. International investing involves a greater degree of risk and increased volatility. Changes in currency exchange rates and differences in accounting and taxation policies outside the U.S. can raise or lower returns. Some overseas markets may not be as politically and economically stable as the United States and other nations. Investments in international markets can be more volatile.
- Investments in commodities may have greater volatility than investments in traditional securities, particularly if the instruments involve leverage.
- The price of equity securities may rise or fall due to the changes in the broad market or changes in a company's financial condition, sometimes rapidly or unpredictably. Equity securities are subject to "stock market risk" meaning that stock prices in general may decline over short or extended periods of time.
Index definitions:
MSCI Emerging Markets (EM) Asia Index captures large and mid cap representation across Emerging Markets countries. The index covers approximately 85% of the free float-adjusted market capitalization in each country.
MSCI AC Asia ex Japan Index captures large and mid cap representation across 2 of 3 Developed Markets (DM) countries* (excluding Japan) and 8 Emerging Markets (EM) countries in Asia.
Bloomberg Commodity Index (BCOM) is a benchmark index that tracks the performance of a basket of commodity futures contracts, aiming to provide broad-based exposure to the commodities market while minimizing concentration in any single commodity or sector.
Important Information
We revisit EM winners from the last trade war, assess the impact of surging Chinese imports into these markets, and identify which EM economies might still shine as global trade frictions flare up again.
Alex Wolf
Head of Asia Investment Strategy
Weiheng Chen
Global Investment Strategist
Published Mar 28, 2025
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